As Asia investment banks cut staff, clients also dumped

The region’s initial public offering boom has slowed - the $20 billion mega-IPOs by Agricultural Bank of China and insurer AIA Group Ltd are now more than two years ago - and the banks’ business model needs a refresh.

One head of a global investment bank in Asia said he sees “no path to profitability” for stand-alone investment banking in the region. Others say Asian companies don’t use investment banks loyally enough, or often enough, to sustain the broad-based investment banking coverage model that grew up in the years before the financial crisis.

Banks resisted making cuts in the wake of the crisis and as IPO fees began to recede. Now, with few deals and thin fee streams, investment banks in Asia are wielding the axe.

That means culling unproductive investment bankers and squeezing efficiencies from those remaining by having them cross-sell commercial banking products such as cash management and foreign exchange services. It also means servicing fewer corporate clients. Some banks that look after 1,000 companies or more are halving those numbers and focusing on fewer mid-sized, private businesses.

“The challenge in Asia is that you don’t know where the revenue is going to come from. The U.S. and Europe have serial fee payers. In Asia, you don’t know, year on year, who’s going to pay,” said one senior banker in the region, who didn’t want to be named due to the sensitivity of bank/client relationships.

RE-MAKE, RE-MODEL

In the United States, more than 1,500 companies have each paid a cumulative $20 million or more in fees since 2008 for investment banking services. In Asia, there are fewer than 300, according to Thomson Reuters/Freeman data. The number of regular fee payers - companies paying at least $3 million a year to investment banks since 2009 - is 318 in the United States, 198 in Western Europe and just 100 in Asia.

As Asia’s banking model shifts from one driven by equities to a more balanced split between debt and M&A products, banks are grappling with a fee structure that is far more inconsistent than anywhere else in the world. A bank can earn $1 million for two hours work on a hastily arranged private funding transaction or lose far more than that by paying a team of bankers to service a major client for years who doesn’t explore a single deal, or pays very little for one.

While the U.S. and Europe have a large group of companies frequently calling on bankers for their dealmaking expertise, data shows that since 2008, four of the top eight estimated fee payers in Asia excluding Japan, are Australian banks, which fund themselves through the bond market. Two others, AIA and Agricultural Bank, were primarily one-off IPO payouts.

INCONSISTENT

While global firms built out their Asian investment banking businesses in the early 2000s, they could wave away the problem of inconsistent fees as the IPO boom more than made up for clients who did no deals, and paid no fees. Banks subsidised expensive cash equities research and trading teams, and sales and structuring teams dealing in equity derivatives - expecting those businesses to flourish further down the line.

That has changed.

Asia IPO volumes are at their lowest since 2008, Thomson Reuters data show, with just $28.9 billion of proceeds raised in January-September against $67 billion in the same period last year and $93.3 billion in the first nine months of 2010.

With thin deal volumes, bank are struggling to generate fees.

A senior Asia banker, who didn’t want to be named while discussing fees, cited one client who took five man-years’ worth of coverage involving 30 bankers for an IPO with just a $2 million fee - about the annual cost of one senior banker. That sort of return, replicated around the region, was overlooked as the IPO bandwagon kept money rolling in, and bank chiefs could tell their global bosses they were still in build-out mode.

But now, investment banks are becoming leaner - and servicing marginal clients is being cut. As that pruning process picks up speed, clients are taking notice.

“Coverage has turned less intense,” said the chief financial officer of a Chinese technology company, referring to the frequency of investment bankers’ visits to his company to offer advice and solicit business.

Indeed, companies are also now in a position to call the shots. Several bankers referred to companies specifically asking them to halt “fly-ins” - where a bank jets in its chief executive to make the case for a deal mandate. And, rather than paying a flat IPO fee, companies are tying fees to how much interest banks can whip up from cornerstone investors - the big shareholders who sign up early to buy into an offering.

CROSS-SELLING

Investment bank chiefs in Asia are reluctant to speak on the record about what one describes as “firing” clients. Privately, though, they confirm they are more aggressive about telling their bankers to drop companies that have taken up time and effort over the years without striking any deals.

Bank bosses are also frustrated by how clients in Asia view investment banks as interchangeable low-cost service providers.

The Chinese CFO said cost is the most important factor in choosing which bank he uses, followed by the level of service provided and the bank’s track record. Least important, he said, was the length of the professional relationship and the bank’s ability to provide other products.

This all means bankers are having to work harder to de-commoditise themselves, bringing clients new ideas or securing powerful investors on any deal that rivals couldn’t reach.

Banks are also pulling back on ‘relationship lending’ - providing loans for clients in the hope they might give the bank a bond or advisory mandate at a later date.

“We’re much more selective in the use of our balance sheet,” said a regional manager at a U.S. bank in Asia. “We might sponsor a big cross-border M&A deal, for example, but forget about the smaller ones.”

Bankers have long held that core investment banking - the fees from stock and bond underwriting, and advising on M&A - is a break-even game for top banks and a loss-maker for the rest. Global firms maintain these platforms for strategic reasons, to service global clients and make money from add-on services such as cash management, escrow and providing hedging.

ADD-ON SERVICES

Banks were willing to take that hit in order to gain league table credentials they can use to pitch for other deals; to keep good relations with governments; and to build add-on business around the deal. Citi, for example, made $18 million from holding funds for the Coal India deal in an escrow account prior to its opening, according to a person familiar with the deal.

The idea is catching on. This year, Bank of America Merrill Lynch integrated its corporate and investment banking units, following Citi, which underwent the process in 2009 in Asia, and JP Morgan. Commercial banks such as HSBC and Standard Chartered are arriving at the same place via a different route, hiring capital markets and M&A bankers to provide those services to loyal lending clients who have previously gone to rival investment banks.

The new approach is exemplified by what happens when a firm misses a deal, according to a director at another U.S. bank.

“It used to be that, in Asia, if we miss a $500 million IPO for a client we don’t cover, someone’s still going to get shot. Now, we’re just focused on a core list of platinum clients, and we’re only in trouble if we miss a deal for one of them.”